Cromwell Property Group
’s chief executive,
Paul Weightman
, says a commercial property “bubble" is building in Australia and his company will look to sell assets and significantly reduce its cost of debt before the bubble bursts.

Speaking at an RBS Morgans function in Brisbane on Wednesday, Mr Weightman said the “wall of money" from institutions was compressing yields without proper regard to the fundamentals.

“We are seeing a different bubble developing this time compared to 2006," Mr Weightman said. “The usual driver of cap rate compression is rental growth – people willing to pay higher prices in anticipation of better returns in the future – and we are not seeing that this time."

Cromwell,which has just been included in the S&P/ASX 300 Index, has delivered a dividend yield of 7.84 per cent, which RBS Morgans expects to increase to 8 per cent next year.

But Mr Weightman said it was hard to see where rental growth would come from in the capital cities of the eastern states.

“We have enormous amount of capital from offshore looking to find a home in the Australian market but we have pretty poor underlying property fundamentals."

Deals across both retail and office sectors, backed by offshore investors, have shown some surprising yield compression.

The Investa Commercial Property Fund and the listed Investa Office Fund purchased the 567 Collins Street development in Melbourne on a yield of about 6.7 per cent. That was followed by GPT Wholesale Office Fund which bought a 50 per cent stake in 8 Exhibition Street in Melbourne for $160 million at 6.5 per cent.

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Analysts at Morgan Stanley and UBS are predicting further capitalisation rate compression over the next 12 months.

Morgan Stanley’s
John Meredith
said the major discussion point at a roundtable of Australia’s largest landlords was whether a moderating rental outlook across the office sector would offset any cap rate compression with regard to driving up asset values.

“While some argue that office transactions in the past few weeks have already started to reflect tighter yields, we note mixed views from our round tables on overall cap rates and asset values," Mr Meredith said.

For Mr Weightman, who held a contrary view compared with the rest of the market during the boom of 2006 and sold out before the market collapsed, the next two years will not be the time to share the pack mentality.

“Sometimes the herd isn’t right and we think we are entering another one of those periods," Mr Weightman said.

He said groups who were looking to pay more for speculative developments as opposed to leased up passive assets in the hope of achieving 7 .5 per cent yield were also contributing to a growing bubble.

He said the market was “analogous" to the late 1980s . “If it plays out like 1988, you will see prices bid up to the wazoo and a complete flop in property values."

Mr Weightman said Cromwell was actively looking to sell assets and reduce debt.

“Managing debt in an organisation like ours is more important than managing property.

“The last five years, the only real source of debt capital for us has been in the banks but we are at a point in the cycle now where we think the debt capital markets are starting to reawaken.

“We are seeing a very strong opportunity in the next couple of years to improve both the tenor and price of debt."

Cromwell, while poised to sell assets, is also open to looking at buying the “ugly duckling" mid-tier assets where there was an opportunistic difference in yield compared with prime assets. The company has been mentioned as a prospective buyer for some of the NSW government’s office buildings.